American States issued a commercial insurance policy to Sovereign Chemical, which was effective from February 20, 1995 through February 20, 1996. The policy provided coverage for commercial property, general commercial liability and commercial inland marine coverage.

On January 17, 1996, an employee of Sovereign filed suit against the company alleging that he was wrongfully discharged. The complaint contained nine counts.

On April 12, 1996, Sovereign gave notice of the litigation to American States, demanding that American States provide legal representation and indemnification for the allegations contained in the complaint pursuant to the terms of the insurance contract. Despite this pending litigation, American States failed to furnish any representation to Sovereign for nearly two months, and on June 6, 1996, informed Sovereign that it was denying all coverage and defense costs. On July 12, 1996, American States agreed to assume the defense of Sovereign with regards to the claim of invasion of privacy, alleging that the privacy claim was the only claim that obligated American States to defend and indemnify. On August 30, 1996, American States conceded that it had the obligation to defend the entire litigation, but insisted on replacing Sovereign’s attorney with an attorney of its choice. Sovereign was not comfortable with changing counsel at such a late date and expressed concern that this change may have an adverse effect on settlement negotiations.

In the spirit of cooperation, Sovereign proposed to retain the counsel who had been handling the case from its outset and forward fees at a rate that American States would pay its own defense counsel. Sovereign would then pay any additional legal fees which would, in essence, leave American States in the same position it would have been in had it assumed the defense from the start of the litigation. American States rejected this compromise and refused to honor all defense and indemnity obligations.

Sovereign retained Allen Schulman, who pursued claims for breach of contract, bad faith and punitive damages against American States. On May 10, 2001, a jury returned a verdict for $300,000.00 in compensatory damages and $2 million in punitive damages.